China’s new leaders have taken their first step towards transforming the world’s second-largest economy by sketching out a plan to raise incomes, drive consumption and reduce social unrest by loosening interest rate restrictions.

“Reform guidelines" released by China’s cabinet outline how the central government plans to double incomes by 2020 and reduce what it says is dangerous inequality.

The plan, which has been a decade in the making, may force the Communist Party to reduce its grip on the banking system and promote a greater role for the private sector.

The centrepiece of the blueprint is a plan to allow banks greater flexibility to set interest rates.

Company Profile

First look at new team’s plan

This might help foreign banks, which have struggled in China, compete against Chinese lenders’ cheap sources of funding.

It is the first time the new leadership team, led by incoming president
Xi Jinping
, has provided any firm details on their economic plans. Mr Xi and incoming premier
Li Keqiang
will take office officially at the National People’s Congress in a month.

“China can’t continue to grow without reform," said author
James McGregor
, who has written extensively on the Chinese economy.

“I am optimistic that reform will happen because the Communist Party has no choice."

The guidelines, released late on Tuesday evening, outlined plans to introduce a property tax and reform the household registration system, known as hukou, which restricts access to health and education for about 250 million migrant workers.

It also aims to lift minimum wages in each province to 40 per cent of the local average by 2015.

Document in the works since 2002

“It shows the government is focusing on income distribution instead of income generation."

The release of the eight-page document surprised many as it had been in the works since 2002 and had been through five drafts.

“This income distribution plan was promised by Hu Jintao and Wen Jiabao soon after they came into office [in 2002]," Mr Tao said. “It shows how difficult it is to push through reform with all the vested interest groups in China."

Vested interests are likely to strongly oppose interest rate liberalisation as China’s banks are some of the world’s most profitable.

China watchers noted that the People’s Daily newspaper, the mouthpiece of the Communist Party, didn’t run a front page story on the landmark document.

The government introduced small reforms to interest rates last year but the new guidelines go much further and say banks must “safeguard the rights of depositors".

ANZ’s Mr Liu noted that China’s central bank introduced a short term liquidity operation (SLO) as part of its open market operations earlier this month. He said this was to prepare for “eventual interest rate liberalisation".

Mr Liu said bank deposits accounted for about 120 per cent of GDP in China, compared with 45 per cent for the stockmarket and nearly 200 per cent for property.

Measure of inequality

“Interest rates liberalisation, if it provides a positive return for depositors, will generate a lot of wealth, drive consumption and reduce income inequality," he said.

Another contentious area raised in the document is a plan to increase dividend payments from the largest SOEs.

By the end of 2015, SOEs will be required to increase the amount of earnings they remit back to the state budget by 5 percentage points.

“This represents real progress as central SOEs have gone from paying no dividends before 2007 to a three tiered dividend structure of 10, 15 and 20 per cent," the China Program manager at the Peterson Institute for International Economics,
Nicholas Borst
, said.

The guidelines for improving income inequality come after Beijing released an official Gini Co-efficient in January for the first time since 2000.

The measure of inequality reached 0.47 in 2012, a level described as “dangerous" by United Nations guidelines. It shows China is more unequal that Russia and the United States and broadly in line with Nigeria and Mexico.

Financial sector reform

China is looking to shift its economic drivers away from investment and exports to a greater reliance on domestic consumption.

But while the outgoing lenders often mentioned this so called “rebalancing", they made none of the hard decisions needed.

More than half of China’s economic activity is now generated through government-led fixed asset investment, more than double that of developed economies.

To reduce this reliance on government infrastructure spending as the new leaders are aiming to increase spending on health and education by taking greater dividends from SOEs.

They are also seeking financial sector reform as a means to not only provide higher returns for savers, but also to provide more white collar jobs for the 6 million graduates who leave university each year.